Getting A Trojan Horse Inside The Banks

The federal government gets extra points for being devious. It plans to begin to take over large banks by giving them money and using the capital they have already invested for a portion of their common shares. It is a step shy of nationalization, but a very short step.

The action allows the Administration to control banks without taking them under its wing and essentially folding their balance sheets into the Treasury’s.

The first big bank that the government is working over is Citigroup (C) which has already gotten tremendous assistance through loans and asset guarantees. According to The Wall Street Journal, “While the discussions could fall apart, the government could wind up holding as much as 40% of Citigroup’s common stock.” It is hard to say whether the move would be good for shareholders. They face dilution, but the bank gets saved.

Maybe.

Because the government’s involvement in Citi would still remain at arm’s length, it may still let the big bank go into a liquidation, If necessary. Citi’s balance sheet may be so burdened with toxic paper that outright ownership by the government could cost taxpayers hundreds of billions of dollars. Citi may no longer be too big to fail if the firm can be married to a more healthy institution like (JPM). with the government only guaranteeing certain assets. As Citi’s major shareholder, engineering that deal would be simple.

Taxpayers should see the government’s move on Citi for what it is. In exchange for what has been a modest investment, the Administration controls the bank and can do with it as it pleases, even if that means flushing it into oblivion to stabilize the rest of the financial system.

The only question left is whether there are any banks behind Citi on the list of places that will be visited by the government’s Trojan Horse.